Question 22 of 22

Question 22

Question text not reproduced: the examination questions are © Engineers and Geoscientists BC. Open the official past paper (linked at the top of this page) to read the question, then follow the worked solution below.

Given. A shale-oil well is drilled, fractured and tied in for a total (100%-interest) capital cost of $10,000,000, spent in Year 1. The Working Interest (WI) owner holds 50%; a 5% royalty is paid to the mineral owner. Average gross production is 500 BOPD in Year 1, declining 30%/yr; oil price is $50/bbl in Year 1, increasing $10/yr; total OPEX is 15% of total capital in Year 1, increasing 10%/yr; the Hurdle Rate is 10%. Taxes and inflation are ignored; all values are shown to the nearest thousand dollars (k$).

Find. The complete Cash Flow table (12 columns, Years 1–4) for the WI owner, and whether the investment meets the 10% Hurdle Rate, the return on investment, and the approximate payout.

Approach. Build the WI owner's production and price stream year by year, split gross production down to net (WI, then royalty), form revenue, subtract the WI owner's share of CAPEX and OPEX to get net income, then test that stream against the hurdle rate by discounting.

1. Production and revenue (Year 1 shown; repeat for Years 2–4). Gross production declines 30%/yr from 500 BOPD: $$\text{Gross}_1 = 500\times365 = \boxed{182{,}500\text{ bbl}}$$Split to net-of-royalty production, then apply the year's oil price:$$\text{WI share} = 182{,}500\times0.50 = 91{,}250\text{ bbl}, \quad \text{Royalty} = 91{,}250\times0.05 = 4{,}562.5\text{ bbl}$$$$\text{Net}_1 = 91{,}250 - 4{,}562.5 = 86{,}687.5\text{ bbl}, \quad \text{Revenue}_1 = \frac{86{,}687.5\times\$50}{1000} = \boxed{4{,}334.4\text{ k\$}}$$Years 2–4 repeat the same three steps with production declining 30%/yr further and price rising $10/bbl/yr.
2. CAPEX and OPEX (WI share). All CAPEX falls in Year 1: $$\text{CAPEX}_1 = \frac{\$10{,}000{,}000\times0.50}{1000} = \boxed{5{,}000\text{ k\$}}, \qquad \text{CAPEX}_{2,3,4}=0$$Total OPEX (100% interest) starts at 15% of total capital and escalates 10%/yr, then is scaled by WI:$$\text{OPEX}_{1,\text{total}} = 0.15\times\$10{,}000{,}000 = \$1{,}500{,}000, \qquad \text{OPEX}_{1,\text{WI}} = \frac{1{,}500{,}000\times0.50}{1000} = \boxed{750\text{ k\$}}$$
3. Net income, cumulative, and NPV@10%. $$\text{Net Income}_1 = \text{Rev}_1 - \text{CAPEX}_1 - \text{OPEX}_1 = 4{,}334.4 - 5{,}000 - 750 = \boxed{-1{,}415.6\text{ k\$}}$$discounted at the 10% hurdle rate using the same start-of-year = time-zero convention as Q21 (Year-n net income divided by $(1.10)^{n-1}$), and running the cumulative total forward, gives the full table below.
4. Hurdle-rate test, ROI, and payout. Summing column 12 (NPV@10%) over all 4 years and comparing to summed column 8 (total CAPEX), per the exam's own stated condition “(12) > (8)”:$$\sum \text{NPV} = 3{,}888.8\text{ k\$} \; \ngtr \; \sum \text{CAPEX} = 5{,}000\text{ k\$} \;\Rightarrow\; \boxed{\text{Hurdle Rate NOT met within the 4-year window}}$$Return on investment (undiscounted, per the exam's own formula (cum.\ income)/(total investment)):$$ROI = \frac{4{,}846.6}{5{,}000} = \boxed{0.969 \;(96.9\%)}$$Payout — cumulative net income is still negative at the end of Year 1 (−1,415.6) and turns positive during Year 2 (+2,815.9 for the year), so payout falls partway through Year 2:$$\text{Payout} = 1 + \frac{1{,}415.6}{2{,}815.9} = \boxed{\approx 1.50\text{ years}}$$